Why The ECB Is NOT Going To Be A Lender Of Last Resort

There are only two real game-changers left in the euro crisis: fiscal union and the ECB stepping in as a lender of last resort (LOLR). The former for now is resolutely off the table, particularly in the time period necessary for it to keep the eurozone together. Very bright people have fallen on both sides of the debate whether the ECB will step in as LOLR. For a number of reasons, even when push comes to shove, I don’t think it will.

I reject the notion that the ECB going all in and firing up the printing presses would solve the euro crisis. The ECB becoming a LOLR would not unwind all the imbalances within the eurozone, nor would it restructure the weaker countries’ economies so that they could regain competitiveness. It would certainly help countries in the eye of the storm issue debt at sustainable rates, but there are a few problems with the ECB serving this role.

First, it would be illegal. According to the treaties, the ECB cannot monetise debt. If it were to take on the role of LOLR, someone would take the ECB to court (there is already a court case in the ECJ against the ECB for its securities markets programme, the SMP, which is sterilized and technically legal) and would win that case. Of course, legislation can be changed, but that would require a treaty change. Even if all EU countries agreed to revise the mandate of the ECB—a big if—it would take about a year to hold the requisite referendums and to ratify the changes in parliaments. The chances of this treaty change are small, but the chances of it happening in the time frame necessary are even smaller.

Aside from the legal issues, there are ideological barriers as well. In his first press conference following the November governing council meeting, new ECB president Mario Draghi said over and over again that the ECB did not have a mandate to be a LOLR and that its measures to mitigate the crisis are limited and temporary. He was very clear that the ECB is not considering monetizing sovereign debt. This is to some degree a result of devout German opposition to the ECB providing quantitative easing. The president of the Bundesbank, Jens Weidmann, underscored this in an interview with the Financial Times on Sunday. The fear in Germany is that quantitative easing by the ECB would create a moral hazard for weaker countries and would stoke inflation. On the latter point, the memory of hyperinflation that culminated in war is by now a social memory in Germany, but it is a powerful one. In the lobby of the Bundesbank is a framed trillion Reichsmark note. Even if the ECB could print some money without driving up inflation, Germany is dead set against it.